The Chinese authorities are trying to combat the exit of capital from the country by imposing restrictions on overseas investments by Chinese companies. Concern about a slowing or complete halt in investment by Chinese companies in Israeli companies yesterday resulted in steep falls in the shares of public companies that have attempted to obtain investment from Chinese sources. In recent years, various Chinese concerns have been expressing growing interest in the Israeli high-tech industry. It was previously reported that Alibaba and Baidu were considering establishing development centers in Israel. At the same time, Chinese concerns have made direct and indirect investments in venture capital funds that invest in Israel, and in certain cases, also in startups. In many cases, the investments were made at relatively high values, and also in companies that could find no other capital, thereby rescuing these companies, mainly at times when investments from the US were hard to come by.
Chinese investments in recent years are believed to have exceeded $500 million, and more burdensome regulation in China is liable to affect the local ecosystem. Will the Chinese decision harm the Start-Up Nation?
First of all, it is important to realize what exactly the Chinese government has decided. According to the news agencies, the supervisory authorities in China are taking action against transfers of Chinese currency abroad by banks, thereby attacking one of the few remaining loopholes in the new capital supervision regime in the country. Tighter supervision is another blow to Chinese strategy of internationalizing (greater involvement in international markets) its currency. This goal has now been pushed aside in favor of stabilizing movements of capital out of the countries and deprecation of the yuan (renminbi) against the dollar.
Sources who received a briefing about the laws that took effect this month explain that banks in Shanghai must now "import" 100 yuan for every 100 yuan they allow a customer to transfer out of the country, in order to ensure that there is no net movement of Chinese currency abroad. Up until now, banks in Shanghai were allowed to transfer 160 yuan for every entry of 100 yuan into China.
The new restrictions are even more extreme. Banks in Beijing must bring back 100 yuan from overseas for every 80 yuan they send there for customers in order to ensure a net flow of currency into China.
The Chinese authorities fear a relatively rapid depreciation of the yuan against the dollar, and acting to slow this depreciation by selling China's foreign currency reserves. In order to preserve China's store of foreign currency, which stood at just over $3 trillion at the end of 2016, the Chinese central bank and government foreign currency manager implemented a series of capital supervisory measures in recent months. In November, the central bank and the Safe transfers company launched more stringent selection procedures for Chinese companies seeking to transfer foreign currency abroad for foreign acquisitions. Dividends and loan repayments by foreign investors have also been subjected to tighter oversight, as well as foreign currency purchases by Chinese citizens.
The transfer of yuan abroad in order to convert it to other currencies was one way of evading the new measures for controlling capital. Such transfers were also consistent with Beijing's aspirations for promoting the yuan as an international currency by encouraging companies to use it in trade deals, loan repayments of shareholders, and dividends. According to the NSBO research company, a net of over than 265 billion yuan ($38.5 billion) left China in September, but this amount has plummeted since the authorities closed the loophole.
"We called for money, and it came"
What are the consequences of this development for the Israel high-tech and venture capital industry? Concerns that work with China insist that things are proceeding as usual. "One of our most significant funds is based on many investments from Chinese sources. Several weeks ago, after the regulation was already in place, we called for money, and it came," says Edouard Cukierman, manager of the Cukierman investment house, which manages the Catalyst Investments LP funds. "Some of the money came from Hong Kong, so it was already in dollars and was not subject to these laws, but some of it was in yuan, and the large funds nevertheless succeeded in getting it out of the country." Cukierman explains that the Chinese legislation was designed to prevent the flight of capital for speculative investments, but the county has an interest in investments in advanced technologies in a country, and will therefore allow them, even if this involves bureaucratic procedures, and therefore takes more time (deals with China have never been fast).
"I returned only yesterday from the Davos conference, in which a large Chinese delegation took part, and from a panel that dealt precisely with this subject. I realized that the strategic Chinese investments would receive more support, not less, and will only increase. In the medium and long term, I don't believe that the legislation will have any effect on Israeli high tech. In the short term, a change in regulation creates uncertainty and stops everything," Cukierman says.
Zvi Shalgo, founder and chairman of the PTL group, which promotes Israeli businesses in China, agrees with him. He says, "The five-year plan published last March puts the level of innovative technology investments at the same proportion as in the past - 10%. It is true that there is a collision with the regulation aimed at halting the outward flow of currency, and we have indeed encountered two companies that were recently unable to transfer money out of China, but we helped them overcome this in cooperation with the government. There is some slowing of investment, until matters get back to normal."
Shalgo notes that the Chinese government is aware that a great deal of money is leaving the country, with investments that are not really strategic being used as an excuse. "It's not so bad if a selection is introduced now, and only really strategic investments are signed. In addition, if an Israeli company now wants to operate in China through a joint venture, there is more capital than ever available," he points out. He adds that in order to overcome the temporary inconvenience, a number of companies have converted their investment agreements into service agreements, "until the big money is released." In other words, solutions to the problem can be found.
Dr. Nissim Darvish, managing partner in Orbimed Israel, which works with Chinese investors, also believes that the regulations can be bypassed, and that only a temporary slowing is involved. In the medium term, serious Chinese investors also have available capital outside of China.
On the other hand, another market source active in China, who was about to sign a deal with China, and had it called off, told "Globes," "Even the Chinese themselves don't really know what will happen. The government there is tough, and bypassing the law is no small matter. In my opinion, it is necessary to assume that the flow of capital from China to Israel has ended, and to look for other sources."
According to Israeli high-tech veteran Eliezer Manor, this decision by the Chinese government is significant, but "It's hard to believe that it will last for long. In the short term, it's unquestionably significant, because it focuses on investments by Chinese venture capital funds and investment funds outside China, and that means Israel, among other things. Companies like Alibaba won't be subjected to this decision. As for its effect in the longer term, it's too early to say."
Manor is one of the founders of the venture capital industry in Israel. He was behind the establishment of the Mofet fund, Israel's first venture capital fund, and was among the founders of IVA, an entity that combined all the local venture capital funds into a single body. He is now founder and president of SIMBA China, a company jointly owned by Israelis and Chinese that helps Chinese investors, both private and governmental, find what they are looking for in the Israeli high-tech market.
Another senior Israeli venture capital figure is not overly excited by the Chinese government's measures. "First of all, the process involved began a year ago. China's desire to invest in innovation was part of its five-year plan for turning China from a manufacturing-based economy into an innovation-based economy. After the Chinese stock market crash, however, a change occurred, and restrictions on taking dollars out of China were introduced. China also noticed that those investments by venture capital funds and investment funds weren't contributing to the Chinese economy, in other words, nothing was coming back from them. The money went on leaving China over the past year, in contrast to what's happening now, because now it's important for the Chinese government that investments help China move forward. The venture capital industry helped China make progress, but at a certain point, the government reached the conclusion that this money was leaving China, but wasn't coming back."
According to this source, "The boom in investments from China was temporary from the beginning. The surge in Chinese investments in Israeli venture capital funds will not be repeated. At the same time, it does look like the continuation of investments in Israeli companies, such as in agriculture, infrastructure, and so forth, is in China's interest. China doesn't lack money; it lacks dollars. The question is only how it can reach Israel, whether directly or through a joint venture. Chinese investments in Israel will continue; only the dialogue will change somewhat. Israel is still very strategic for China."
Benjamin Weiss, managing partner in CEIIF, which recently raised $32.2 million for investments in Israeli technology companies, says, "It is clear that the new regulation will affect all the international markets with a significant dependence on investments from China, including the Israeli venture capital and technology industries. If this indeed causes a decrease in Chinese investments in Israeli technology companies this year, the Chinese investors are liable to be selective in choosing investment targets. On the positive side, business tourism from China to Israel will suffer no negative effects. Israeli venture capital funds and entrepreneurs must be prepared for longer investment processes on the part of Chinese investors; in other words, it will take longer for a deal to be approved and closed. It is possible that investments can be made through Chinese subsidiaries or joint ventures, but it is important to get advice on taxation and legal questions in order to make sure that such investment methods comply with the rules of the new regulations."
Published by Globes [online], Israel Business News - www.globes-online.com - on January 23, 2017
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